BTI 2018 Country Report Latvia This report is part of the Bertelsmann Stiftung’s Transformation Index (BTI) 2018. It covers the period from February 1, 2015 to January 31, 2017. The BTI assesses the transformation toward democracy and a market economy as well as the quality of political management in 129 countries. More on the BTI at http://www.bti-project.org. Please cite as follows: Bertelsmann Stiftung, BTI 2018 Country Report — Latvia. Gütersloh: Bertelsmann Stiftung, 2018. This work is licensed under a Creative Commons Attribution 4.0 International License. Contact Bertelsmann Stiftung Carl-Bertelsmann-Strasse 256 33111 Gütersloh Germany Sabine Donner Phone +49 5241 81 81501 [email protected] Hauke Hartmann Phone +49 5241 81 81389 [email protected] Robert Schwarz Phone +49 5241 81 81402 [email protected] Sabine Steinkamp Phone +49 5241 81 81507 [email protected] BTI 2018 | Latvia 3 Key Indicators Population M 2.0 HDI 0.830 GDP p.c., PPP $ 26031 Pop. growth1 % p.a. -0.9 HDI rank of 188 44 Gini Index 35.1 Life expectancy years 74.1 UN Education Index 0.858 Poverty3 % 0.9 Urban population % 67.4 Gender inequality2 0.191 Aid per capita $ - Sources (as of October 2017): The World Bank, World Development Indicators 2017 | UNDP, Human Development Report 2016. Footnotes: (1) Average annual growth rate. (2) Gender Inequality Index (GII). (3) Percentage of population living on less than $3.20 a day at 2011 international prices. Executive Summary Latvia made great international strides between 2015 and 2017, culminating in the country’s accession to the OECD in 2016. Consequently, Latvia has joined every major western international organization. This was seen as a necessary security development due to the external threat posed by Russia following Russian’s occupation of Crimea. The number of NATO troops hosted by Latvia has also increased, including a battalion of 1,000 Canadian soldiers that arrived in 2017. Meanwhile, the government has committed to gradually raising defense spending with the aim of eventually reaching 2% of GDP in 2018. At the same time, after a heated political debate concerning the country’s response to Europe’s refugee crisis, Latvia eventually accepted a small quota of refugees. However, poor living conditions and job prospects have led many refugees to leave Latvia for Germany and other western European countries, although the terms of their refugee status do not allow them to claim benefits or work outside Latvia. During the period under review, Latvia’s economy grew more sluggishly than in the previous years. This was partially caused by a delay in EU structural spending, demonstrating Latvia’s dependence on EU funds for economic growth. Despite slow economic growth, the budget remained balanced as it has been since the harsh austerity measures introduced between 2008 and 2010, which saw taxes rise and public spending cut, and led to a relatively balanced budget, booming exports and the return of FDI. At a conference in Riga in mid-2012, Christine Lagarde hailed Latvia’s “remarkable” achievements, attributing them to the government’s “political will and ownership,” and readiness to “bite the bullet” and frontload reforms so as not to delay the pain. The government is now focusing on economic reforms to stimulate competitiveness, with major reforms to the tax system, health care financing and the school system planned for 2017. Public pressure on government to address social inequality has also increased, including pressure to introduce progressive taxes and target benefits at those most in need. Despite a change of government in February 2016, the political system has remained stable. The same three parties - the center-right Unity, radical-right National Alliance, and conservative Union BTI 2018 | Latvia 4 of Greens and Farmers - have been in a governing coalition since the October 2014 election. The coalition was initially led by Prime Minister Laimdota Straujuma (Unity), who successfully led Latvia through its presidency of the Council of the European Union in the first half of 2015. However, instability within the Unity party led to a failed coup to oust Straujuma, which resulted in the Union of Greens and Farmers seizing the political initiative and nominating their own leader, Māris Kučinskis, to head the government. He was elected to the post in February 2016. The key long-term challenge for Latvia remains the demographic crisis. The Latvian population has fallen from 2.6 million in 1989 to less than 2 million in 2016. Eurostat projects that (if current trends continue) Latvia will have a population of just 1.4 million in 2050. Low fertility rates and continuing migration to wealthier EU member states has led to a rapid decline in the dependency ratio (i.e., the number of working age people to pensioners). However, successive governments have been unable to introduce any policies to reverse these trends and the Kučinskis government, which has not prioritized this issue, is unlikely to break this pattern. History and Characteristics of Transformation The Latvian territories have been a part of the Swedish, Polish and Russian empires. However, throughout these different eras of empire the effective governors of Latvia remained the Baltic Germans, who had first conquered Latvian territory in crusades against the pagans of northern Europe in the early thirteenth century. The modern Latvian nation emerged in the mid-nineteenth century as a result of Tsarist peasant emancipation, urban industrialization and the subsequent emergence of an educated Latvian middle-class. Independent Latvia emerged in the aftermath of the First World War, as the Russian empire collapsed, and new countries formed all across east and central Europe. The new Latvian state adopted a parliamentary constitution in 1922, although this failed to provide solidity given the formation of 13 government coalitions by 1934. This political instability, accompanied by an economic downturn in the early 1930s, led to a peaceful coup in 1934, and the benign dictatorship of Karlis Ulmanis. He had been the dominant figure of inter-war Latvia, having served as Latvia’s first prime minister and as the head of the committee that declared Latvia’s independence in 1918. These years of dictatorship are remembered with great popular affection largely because of the brutality and violence of the following Soviet and German occupations during the Second World War, and Latvia’s subsequent forced annexation into the Soviet Union. Soviet occupation after 1945 saw the collectivization of agriculture, an increased pace of industrialization and sharp demographic change. The large German and Jewish minorities had virtually disappeared as a result of the holocaust and the dislocations of the Second World War, while many Latvians (largely the middle-class elite) fled west or were deported to Siberia. The post-1945 era saw a large influx of Russian-speakers. The Soviet regime floundered in the 1980s as falling energy prices threatened economic stability, and the democratic reforms of Mikhail Gorbachev allowed the forces of Latvian nationalism to organize and compete in free elections. BTI 2018 | Latvia 5 Three major factions emerged in the late 1980s: The radical nationalists of the Latvian National Independence Movement, the more moderate and inclusive Latvian Popular Front (LPF), and the anti-reform Interfront movement, an amalgamation of pro-Soviet forces primarily composed of ethnic Russian Latvian Communist Party members and Soviet officers who had settled in Latvia after their retirement. The contemporary Latvian party system still largely reflects this order, with radical Latvian nationalist, moderate centrist nationalist and left-leaning pro-Russian-speaker parties in the Latvian parliament. The LPF won a majority in the 1989 elections to the USSR Congress of People’s Deputies, and again in the 1990 elections to the Latvian Supreme Soviet, which then voted to restore independence in May 1990, leading to the establishment of parallel Latvian and Soviet government structures. De facto independence was achieved following the failed August 1991 anti-Gorbachev coup in Moscow. At this point Latvia faced a radical political and economic transition. The political transition to a multiparty democracy began with the re-adoption of the 1922 constitution and the first post-Soviet parliamentary elections in 1993. Since then Latvia has had eight parliamentary elections, all of which have been judged as free and fair by international observers. However, Latvia’s extreme multi-party system has meant that government stability has been hard to come by, with governments lasting, on average, little over a year. The other major political challenges included an agreement on the withdrawal of Russian forces from Latvian territory (reached in 1994), internationally accepted rules on the naturalization of Russian-speaking Soviet-era immigrants and accession to the major Euro-Atlantic organizations (Latvia joined the European Union and NATO in 2004). Reforms to the economy were equally challenging. Many of Latvia’s largest industrial enterprises, such as the electronics manufacturer VEF and the minibus producer RAF, went bankrupt, while others were privatized or returned to previous owners. Unemployment was high in the early 1990s, and the quality of public services fell as government receipts collapsed. Two currency reforms (first instituting the Latvian ruble, then the Latvian lat) and rampant inflation in the early 1990s, as well as the collapse of several commercial banks in the mid-1990s, wiped out people’s savings. However, the mid-2000s saw Latvia experience rapid economic growth, albeit primarily as a result of a construction and consumer-spending boom funded by cheap credit. The Latvian economy fell back to earth in late 2008, and the government turned to an International Monetary Fund (IMF) led international consortium for a financial bailout. A dramatic recession (the deepest in the world) followed, with Latvia experiencing a cumulative GDP decline of 23.9%.